Treasuries Plunge as Traders Bet Trump's Tax-Cut Plan Will Fan Inflation

U.S. Treasury bonds tumbled, sending yields to the highest in nine months, on speculation President-Elect Donald Trump's pledge to slash taxes and increase government spending will fuel higher inflation.

The 10-year Treasury yield climbed 0.17 percentage point to 2.03%, according to FactSet, breaching the 2% threshold for the first time since late January. Prices for the bonds fell, since inflation typically erodes the value of securities with a fixed-rate income stream. 

The yield may reach 2.25% by the end of the year, roughly on par with levels at the start of 2016, as investors become warier of higher prices and as the Federal Reserve proceeds toward an expected rate increase next month, said Brian Brennan, a fixed-income portfolio manager at the $813 billion money manager T. Rowe Price.

A further jump in the yield is likely "if there's any hint toward the U.S. having more leeway to do more on the fiscal side, which would increase investor inflation expectations," Brennan said.

Trump has made across-the-board tax cuts a cornerstone of his economic plan, pledging on his campaign website that "no one will pay so much that it destroys jobs or undermines our ability to compete." The business tax rate would drop to 15% from 35%, while corporations would get a one-time chance to repatriate foreign profits at a rate of 10%.

At the same time, Trump says he would support more spending on transportation and telecommunications infrastructure, clean water and electricity transmission as part of a "golden opportunity" to accelerate economic growth and create thousands of jobs in construction and manufacturing.

Republicans' hold on both the Senate and House of Representatives mean Trump probably will be able to push through his economic agenda, said Ajay Rajadhyaksha, global head of fixed-income research at Barclays in New York.

"He seems to have been advocate of fiscal stimulus, easy-money policies, and at this point he has that ability to get what he wants through Congress," Rajadhyaksha said. "So the markets are saying, well, if that's what he wants, then that explains the selloff in Treasuries."

Fitch Ratings said in a statement today that Trump's economic and fiscal policies would hurt the U.S. government's creditworthiness if implemented in full, since tax cuts wouldn't create enough growth to make up for the loss in revenue.

"A rapid move into substantial fiscal deficit by the U.S. could push up borrowing costs," the Fitch analysts wrote.

Stefan Kreuzkamp, chief investment officer of Deutsche Bank's money-management unit, said in a note to clients today that higher volatility looms for the Treasury market.

"Trump's plans for lower taxes and higher spending would amount to a massive fiscal stimulus, at a time when the U.S. is already close to full employment," Kreuzkamp wrote. "If enacted at anywhere near the scale indicated during the campaign, the effects would be higher economic growth in the short term, eventually leading to higher inflation and higher interest rates."

One caveat: Markets could reverse if Trump follows through with his anti-trade campaign rhetoric and adopts a tougher stance toward countries like China and Mexico, Barclays' Rajadhyaksha said. Such policies would reduce the likelihood that the Fed proceeds with current projections for two interest-rate hikes in 2017, he said.

"If anti-trade is a bigger part of the Trump platform early next year, we could change our view," the analyst said. "Markets would take that poorly, and we have seen repeatedly that this is a Fed that doesn't like to hike if financial-market volatility is picking up sharply."

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